Estimating the Wage Curve with Spatial Effects and Spline Functions

In this paper, we provide new empirical evidence on the relationship between regional wages and unemployment using spatial econometric techniques and allowing for nonlinearities in the model. The estimates are based on Austrian administrative data for the year 2001. The wage elasticity with respect to the unemployment rate is about -0.03 and thus quite low in international comparison. This can be explained by institutional characteristics of the Austrian wage bargaining system. Allowing for a more flexible functional form by estimating a model with linear spline functions, we find that the wage curve is only present in areas with a medium level of unemployment. The often used quadratic specification is therefore inadequate in describing the shape of the earnings unemployment relationship. Finally, we show how OLS tends to overestimate the wage-curve elasticity in absolute terms.